Mr. Kravis Goes to Washington (Capra Rolls Over)

WASHINGTON, July 10 — Henry R. Kravis, the billionaire founder of the corporate buyout movement, was working the hallways of Capitol Hill, hoping to kill legislation that would raise his taxes and those of other investment fund executives.

While known to powerful people in Washington through longstanding personal and social ties, Mr. Kravis is an unfamiliar figure in many suites of Congress and typically leaves the glad-handing of lobbying to lesser functionaries.

Meeting two weeks ago with Representative Sander M. Levin, a senior Democrat who is proposing to more than double the amount of tax that Mr. Kravis now pays, the buyout titan mustered his best arguments. He said that firms like Kohlberg Kravis Roberts play a central role in the economy, participants recalled, citing the example of how his firm had produced many jobs in Mr. Levin’s home state when it turned around a troubled electricity company in Michigan. He asserted that the lower tax rate benefited all Americans. And he said that an increase in tax rates would harm American competitiveness abroad.

Mr. Levin and his staff were unswayed. One aide asked Mr. Kravis to explain whether the measure would hurt workers and middle-income families by lowering the returns for pension funds that invest in Kohlberg Kravis funds, two aides at the meeting recalled. They said Mr. Kravis agreed with an answer by a partner that the proposal would not hurt returns, and the meeting ended soon afterward.

On the eve of Congressional hearings, managers of private equity firms and hedge funds, who for years remained aloof to Washington’s concerns about their growing financial power, have been caught flat-footed. Fighting a fierce lobbying battle over one of the most contentious and consequential tax proposals in the last decade, they have quickly assembled a huge lobbying machine, formed alliances with other industries, and quietly worked the hallways of Congress.

In recent weeks, lawmakers have had visits from industry leaders including Stephen A. Schwartzman, the head of the Blackstone Group, and David M. Rubenstein, a senior executive and co-founder of the Carlyle Group who served in the Carter administration as a domestic policy adviser.

But Mr. Kravis’s encounter illustrated the difficulties that private equity firm executives and their lobbyists face as lawmakers question their sky-high salaries and tax brackets that are lower than those of many less-affluent Americans. And it foreshadowed an uphill political battle, even as the industry pulls out the stops to wage an intense lobbying campaign.

Democrats are hoping that billions of additional dollars in tax revenue from the private equity industry, as well as some players in the hedge fund arena, could help to finance education tax credits, broader health programs for lower-income families, and new limits on the growing reach of the alternative minimum tax.

On Wednesday, the Senate Finance Committee will hold its first hearing on one of the proposals, and the House Financial Services Committee will look at the risks that hedge funds pose to the overall financial system. But the next big political moment will come when the Joint Committee on Taxation estimates how much money the proposals would raise if they became law.

Since shortly after the Blackstone Group announced plans to go public, its lawyers began to receive a steady stream of tax questions from the staff of the Senate Finance Committee, although there was little anticipation among other companies of the widespread political support for a tax increase.

The industry’s leaders include a variety of seasoned political hands. The senior chairman and co-founder of the Blackstone Group, for instance, is Peter G. Peterson, a former White House official and commerce secretary. Mr. Kravis’s ties to the Bush family go back decades, to the time when his father was friends with Senator Prescott Bush, the president’s grandfather. Another major player in the debate, the Carlyle Group, is based in Washington and led by a group of well-connected former top government officials.

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The private equity firms have formed alliances with other industries, like real estate, energy and venture capital, and retained a battery of lobbyists with strong connections in both parties. They have showered presidential and Congressional campaigns with millions of dollars in contributions. Industry executives are also counting on the support of powerful Democratic lawmakers who happen to rely on Wall Street as a major source of political contributions. They include Senators Charles E. Schumer of New York and Christopher Dodd of Connecticut, and Representative Rahm Emanuel of Illinois. They have not taken a public position on the bills.

Opponents of the tax rate increases, framing the debate in broad strokes, say that raising rates could be the first step in increasing rates for more than just equity funds and their managers.

“This will not be a political fight about the definition of what is a capital gain,” said Wayne L. Berman, managing director at Ogilvy Government Relations and a major Republican fund-raiser. The firm represents Blackstone and Carlyle. “It will be a broader fight about the fairness of capital gains having a lower tax rate. It will be about rewarding risk and recognizing that when you reward risk you create economic growth.”

“This is pure politics,” he said. “This is about the A.F.L.-C.I.O.’s longstanding policy objective of ending the beneficial tax treatment of risk versus the treatment of wages from work.”

“It is not about Steve Schwartzman’s birthday party,” he added, referring to the lavish 60th birthday celebration for Blackstone’s co-founder in February.

The newly founded Private Equity Council, which represents the largest industry players, has retained a battery of lobbyists from Akin Gump Strauss Hauer Feld; Capitol Tax Partners; Brownstein Hyatt Farber Schreck; and Johnson, Madigan, Peck, Boland & Stewart. Kohlberg has several well-positioned lobbyists, including Kenneth B. Mehlman, a former chairman of the Republican National Committee, who is a partner at Akin Gump.

The pay-as-you-go rules adopted by lawmakers require Congress to offset any tax cuts with new revenue. Senior lawmakers, hoping to limit the encroaching alternative minimum tax and adopt other measures that benefit middle-income families, view the highly prosperous private equity funds as a golden goose. They see the industry, which has been secretive in its business practices but bathed in recent publicity of $1 billion paychecks and opulent lifestyles, as a juicy and largely unpopular target. The industry is set up so that owners pay a capital gains tax rate of only 15 percent on much of their partnership income, versus the 35 percent rate that they could otherwise pay on ordinary income.

“The tax subsidy to the wealthiest Americans created by these lower rates on equity funds is a significant drain on the ability to do important things for the good of the country,” said Damon A. Silvers, associate general counsel at the A.F.L.-C.I.O., which has been lobbying in support of increasing the rates. “The top 25 individuals in the industry got paid over $10 billion, taxed at a rate of 15 percent. Those 25 people got paid three times the amount that was paid to all 80,000 people who teach in the New York City schools, and they paid roughly one-half to one-third of taxes on a percentage basis.”

Last month, Senators Max S. Baucus of Montana and Charles E. Grassley of Iowa, the chairman and ranking Republican of the Senate Finance Committee, introduced a bill that would raise the 15 percent tax rate on certain partnerships that go public, like Blackstone, to the top rate of 35 percent.

A week later, Representative Levin, joined by such senior Democrats as Representative Charles B. Rangel of New York and Representative Barney Frank of Massachusetts, offered a bill that would raise taxes on the investment gains of partnerships, including fund managers, to the ordinary income rate of as much as 35 percent, from the capital gains rate of 15 percent.

“Many in the industry have been politically active for their own political beliefs and are now starting to understand political activism on behalf of their business,” said Lisa S. McGreevy, executive vice president of the Managed Funds Association.

Correction: July 17, 2007

An article in Business Day on Wednesday about lobbying by hedge fund and private equity fund executives against a proposal that would increase their tax liability misspelled the surname of one executive, a co-founder of the Blackstone Group. He is Stephen A. Schwarzman, not Schwartzman.

Stephen Labaton reported from Washington and Jenny Anderson from New York.

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